Severance Plan Alert: Is ERISA Compliance Required?

Severance Plan.BLOGIn a recent ruling, the Second Circuit determined that an employer’s “severance plan” was subject to the Employee Retirement Income Security Act (ERISA). Okun, M.D. v. Montefiore Medical Center (2nd Cir. 2015). For employers facing a sensitive employee termination, the decision leaves much to consider. Shall we offer this employee a termination agreement in exchange for a waiver of potential claims? If so, should we follow the same pay-for-length-of-service formula we used for the last person we offered an agreement? How many termination agreements does it take to create an ERISA Severance Plan? The answers depend upon the facts of the situation.

In this case, the employer paid physicians terminated for any reason other than cause a six-month severance. Any eligible employee with at least 15 years of service was given an “automatic” review of the amount of severance by the company president. The employer never thought it was running an ERISA Severance Plan. Nonetheless, a separated pediatrician with 23 years of service sued the employer for interfering with his ERISA severance benefits.

ERISA broadly defines an “employee welfare benefit plan” as “any plan, fund, or program … maintained by an employer … to the extent that such plan, fund or program was established … for the purpose of providing participants … benefits in the event of sickness, accident, disability, death or unemployment … .” 29 U.S.C. § 1002(1). The court used a three-prong analysis to determine whether the employer’s practice was subject to ERISA. First, did the employer’s undertaking or obligation require managerial discretion in its administration? Second, would an employee have a reasonable expectation of receiving a severance payment upon termination? Finally, was the employer required to analyze the facts of each employee’s termination separately in light of specific criteria?

Here, the pediatrician gave four months’ notice that he had accepted another position. Less than a week after providing notice, he was told that comments he made in a meeting were unacceptable, and he would be terminated for cause, making him ineligible for the severance payments other departing employees had consistently received. He filed suit against the employer, claiming that their “for cause” decision was a pretext to interfere with his right to receive his due payment from an ERISA Severance Plan. The employer argued that it had no such plan.

The court concluded that managerial discretion was both required and used, for example, in determining whether each termination was or was not “for cause.” Second, given that most employees who separated were paid severance, a “practice” the employer had followed since 1987, the court concluded that receipt of severance was a reasonable expectation. With regard to the third prong, the court considered, among other things, that the president reviewed each long-service severance amount prior to payment and found that the employer did analyze the facts of each termination.

While they may have used less discretion than other employers who were found to have ERISA plans, these facts were enough for the court to conclude an ERISA Plan was in place. This decision subjects the employer to all the requirements of a compliant ERISA Plan, one of which is no interference with an earned severance benefit.

Having ruled that the payment was, in fact, subject to ERISA, the court remanded the case back to the District Court to determine whether the employer interfered with the employee’s ERISA benefit payment.

Employers who do not have the protections of a compliant ERISA Severance Plan must be careful when considering whether to offer a termination agreement to a departing employee. While the incentive to do so may be a waiver of claims or an intended good-faith send off, the risk is that a court could determine the offer was made under a non-compliant ERISA Plan.

Employers who have adopted compliant ERISA Severance Plans generally obtain the following protections:

  1. If challenged in court, an employer can remove the case from state court into the protections of federal court using ERISA preemption. Sometimes removal alone discourages complainants from pursuing the matter further.

  2. ERISA plans are protected from punitive and compensatory damage awards, whereas a termination agreement litigated in state court may subject the employer to paying both types of damages in addition to the severance amount.

  3. Judges are obligated to give deference to the terms of the ERISA Severance Plan document, essentially awarding no more than the plan document provides. Whereas, an individual agreement litigated in state court gives the judge full discretion in awarding the complainant whatever severance amount the judge deems reasonable and appropriate under the circumstances.

  4. Once the ERISA-compliant severance plan is drafted, adopted, and communicated, essentially the only ongoing requirement is for employers who have more than 100 employees to file an annual Form 5500.

Employers are advised to review their practice, if any, with regard to payment in the event of an employee termination. The court here specifically stated that most employer obligations to pay severance benefits, when analyzed by courts, are held to be employee welfare benefit plans within the meaning of ERISA when they involve some ongoing administrative scheme. Conversely, a one-time employer promise to make a lump-sum payment triggered by a single event is less likely to implicate an ongoing administrative scheme or declaration of an ERISA benefit plan. Ultimately, courts make each decision only after evaluating the facts of the severance payment.